Profiting from the coming online education revolution – Part I

In a well-written and thought-provoking article appearing on MSN MoneyCentral yesterday, writer Zephyr Teachout pondered the point: “Will the Web kill colleges?” Using a parallel example of the web all but putting the final nail in the coffin of traditional newspapers, the author claims that non-brand name bricks and mortar colleges (read: the non-Ivies) will suffer a similar fate. After all, newspapers and colleges are both in the business of disseminating information and no instrument does that as cheaply nor as conveniently as the internet.

But is it too soon to pay our last respects to the university system as we know it?

Change is coming
Teachout (whose day job is teaching law) says that “It is hard to predict the precise pace of change, but it’s possible that within 15 years most college credits will come from classes taken online. In 2007, nearly 4 million students took at least one online course, and the numbers are growing. Within a generation, college will be a mostly virtual experience for the average student. The Ivys [sic] will be much less affected than the middle tier and local schools. But colleges that depend on tuition and have no special brand will be hit hard. The recession will accelerate this trend as students become warier of taking on loans and state schools experiment after funding cuts.”

None of this should come as a shock to most people, especially the millions who have taken at least one class online. But who are going to be the big winners in this space? Since the entire field of online education is still in its relative infancy, predicting who the major players will be even in the not-too-distant future is difficult especially since the technologies that will enable the transition from classroom to computer are still being developed. But there are several places we can look to right now.

The obvious place to look at are the companies that are already making headway into the virtual education space–the for-profit educators. The more well-known names in this group are ITT Tech (ESI), DeVry (DV), and University of Phoenix (APOL). One nice thing about this industry group is it’s counter-recessionary nature: When the economy was sinking last year, many of these stocks were rising, presumably because those who had lost their jobs were going back to school to be retrained in more promising job areas.

Although the past couple of years have been good, what does the future portend?

Suzanne Stein, an education analyst at Morgan Stanley, said recently that she expects 12% to 15% growth in the for-profit educators over the next 12 months. Citing the large income disparity between those with college degrees and those without along with the escalating cost of higher education, Stein feels that online educational services can only grow. But she’s careful to point out that investors should focus on those education providers with lower valuations because negative changes in the regulatory environment would have less impact on them and in a positive environment they would benefit more.

Her strategy is to sell the perceived quality companies like Strayer (STRA) and Capella (CPLA) and buy the lower-priced spreads such as the Apollo Group (includes U. Phoenix), ITT Tech, DeVry, and American Public (APEI). [Note: She didn’t say what metrics she uses to value these companies, and from what I can tell, it’s not based on P/E, EPS ,or book value. The companies with the highest price-to-book ratios are ESI and STRA; the two with the lowest are APEI and DV.]

Technical considerations
Looking at the charts, the ones that she mentions as being the most undervalued also happen to be the ones that have fared the worst in recent months. American Public is off nearly a third from its 9/2008 high. DeVry, ITT Tech, and Apollo are all off 15%, 20%, and 25% respectively from their most recent highs, while Strayer and Capella are down 15% and 6%. Maybe there is something to be said for quality after all!

For those of you interested in channeling stocks, you may want to take a closer here as  some of these names have been channeling nicely over the past two years. Here’s the range for a few of the better channelers:

DeVry, DV ($51): $40 – $60
Strayer, STRA ($203): $160 – $220
Capella, CPLA ($61): $50 – $65

DV Chart 9-16-09

Looking overseas
What can be said for the prospects of American for-profit educators can be said doubly for similar entities overseas, especially China given the country’s thirst for growth. I found six Chinese concerns involved in for-profit education that trade on US exchanges: New Oriental Ed. (EDU), China Distance Ed. (DL), ChinaCast Ed. (CAST), ATA (ATAI), ChinaEdu (CEDU), and China Ed. Alliance (CEU).

All of these are priced in the $6-$7 range except for New Oriental (EDU) which trades at ten times that ($76). It is also the largest of these companies and it’s my pick of the litter based on technicals: it’s been moving up while its brethren have been languishing.

EDU Chart 9-16-09

Summary
The for-profit educators are only one aspect of the online pie that’s waiting to be divvied up. In an upcoming blog, I’ll be looking at other types of companies that stand to profit from the toppling of the Ivory Tower.

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